Observations by David Robertson, 2/3/23
It was a crazy week for stocks and the Fed was right smack in the middle of it all. If you want to follow up on anything along the way, just let me know at email@example.com.
This chart from @SoberLook shows flows into emerging market assets are hitting levels as high as they have been in at least the last five years.
Almost Daily Grant’s from January 31st, 2023 characterized Friday’s trading in Tesla as “a veritable bacchanalia in derivatives”. It continued describing the background that led to “Tesla’s 23% rally on Thursday and Friday”:
Friday’s fiesta was no fluke, as daily Tesla options volume now stands at an average 3 million contracts, double the turnover seen a year ago and more than any security other than the SPDR S&P 500 exchange traded fund. Pie-in-the-sky price moves figure prominently in those punter’s plans, as the Journal notes that contracts requiring an $825 share price (double Tesla’s all-time high) within 12 months were among Friday’s most actively traded.
‘E’ Is for Europe at the Epicenter of Everything ($)
the big data point to move markets on Monday was Spanish inflation. This is not normally regarded as a “first-tier” number, and over time economists have been very good at predicting it in advance. But last month’s was a nasty surprise. Not only did Spanish inflation rise a little, rather than continuing a marked downward trend, but it also deviated from forecasts by the most in any month since 2010 …
With euphoria blossoming from seemingly every data point whether good or bad, Spanish inflation stuck out like a sore thumb. While it is possible this was just an anomaly, it probably serves as a good reminder of just how erratic and unpredictable inflationary trends can be.
Finally, VIX, the volatility measure, has been careening downward and after the FOMC meeting, got absolutely crushed. It is now significantly lower than at any point in the last year. Party on Wayne.
Amidst all the talk of recession and inverted yield curves, US consumers beg to differ. That point is made here by @RobinBrooksIIF and was confirmed by the earnings calls of the major credit card companies as well. Things can certainly change in the future, but right now, the consumer economy is just fine.
Interesting update on the housing market from the CEO of Redfin. He describes January as “not as bad as December” and points to mortgage rates off their highs as part of the reason. Another part of the reason seems to be something of a transformation of the housing business:
Maybe the sea change our country was going through, in which each of us got to live where he wants, wasn’t a fad but unfinished business, cut short by a rate hike. The market could still easily falter. But housing in January has been stronger than anyone could’ve hoped.
The quote that caught my attention was, “People are really trying to find their sanctuary.” Insofar as this is the case, it is one more piece of evidence of how Covid has reshaped several core aspects of our lives. For example, Jim Bianco has argued persuasively the relationship between work and office has fundamentally changed. People have re-evaluated the conditions under which they work and increasingly, it appears, the conditions under which they live at home.
To the extent people can significantly untether their household locations from their work office locations, there is likely to be some significant reshaping of demographic patters over time.
Dispatch from the bustling Permian ($)
Both [forecasts] see deep electrification of cars and trucks. One of the biggest differences is that Exxon believes booming demand for oil in things such as plastics and chemicals will more than make up for the boom in EVs.
I talked about oil forecasts a bit last week and this week the topic arose again in a slightly different form. This is about very long-term forecasts and the massive disparity between BP and Exxon.
One point is you can be sure there is good work and research behind both forecasts. Large oil companies take longer-term planning seriously because it is a critical input for capital spending on projects that take many years to develop.
Another point is any forecast going out that far must necessarily be laden with assumptions. Almost certainly, this is where the biggest differences are. In this particular case, the big difference seems to revolve around the forecast for plastics and chemicals.
This is an interesting point. To date, the loudest case against oil is based on its replacement by electric power in transportation. While the all-in costs of electric vehicles are becoming more evident, however, even that case is becoming weaker.
What almost nobody is discussing is the set of non-fossil-fuel-based alternatives for chemicals and plastics. Until we start hearing more about those, it is safe to assume consumption isn’t going to decline very much.
Five Rules for an Aging World ($)
Meanwhile, variations on that [demographic] shadow lie over most rich and many middle-income nations now — threatening general sclerosis, a loss of dynamism and innovation, and a zero-sum struggle between a swollen retired population and the overburdened young.
This article gets more specific than it probably should on some forecasts, but the basic premise is a good one: In an environment of aging (and soon to be declining) populations, the rules are different. Things are easy when growth is the natural state of affairs. Mistakes are easily patched over by new growth.
When growth stops, however, mistakes become more costly and reactionary policy-making becomes more costly. The entire foundation of policy-making gets shaken. Just consider the first “rule” for an aging world: “The rich world will need redistribution back from old to young”.
This idea isn’t especially controversial, but let’s think through what it implies. A generation of Baby Boomers has a belief system based on the notion they have worked their tails off to secure a comfortable retirement. Social security, Medicare, pension plans and other retirement benefits are promises they fully intend to cash in on. Any kind of redistribution, through taxes, inflation, or otherwise, is likely to be met with howls of protest.
As a result, it will be very difficult for public policy to evolve with an aging population. It will evolve because it has to. But it will take longer and be more painful than it should. Unfortunately, however, this should be the baseline expectation for policy from pretty much every aging society.
Thanks for reading Observations by David Robertson! Subscribe for free to receive new posts and support my work.
As usual, the FOMC meeting was the news of the week. Both the press release and press conference afterwards were pretty much in line with expectations. It is looking a lot like there will be a couple more 25 bps hikes and that will be it.
The market must have heard some ineluctable siren song because it popped while Powell was speaking and never looked back. Volatility got crushed.
One of the notable happenings was Powell’s nonchalance ($) about the gap between Fed forecasts for inflation and the market’s. Another was his dismissiveness ($) about the recent easing of financial conditions.
This creates a wide range of possible interpretations - which begs its own question: Knowing that an overly exuberant market can undermine monetary policy goals of reining in inflation, why not be clearer about what the Fed doesn’t want to have happen? For what it’s worth, it struck me that Powell is growing weary of the whole process and just doesn’t have the energy to micromanage every last detail of communication any more.
With so much attention placed on rates, the Fed’s Quantitative Tightening (QT) program is still getting relegated to the backburner. This is somewhat understandable for traders who are looking for a short-term directional bet. For longer-term investors, however, QT is the program that matters most because it represents a long, gradual withdrawal of liquidity, and because it is going to reshape the monetary system.
As @Stimpyz1 highlights, the ultimate goal of QT is to crowd out a large universe of “synthetic safety”, aka, the top tranches of securitizations. The reason is simple - these financial contraptions effectively create money - and do so completely outside of the Fed’s control. The Fed would very much like to regain control over money supply to ensure policy efficacy.
The Fed would also like to crack down on securitizations to ensure its own survival. If a central bank can’t effectively do the only thing it was created to do, i.e., control money supply, there is no reason to keep it around. The fact that QT addresses both policy concerns and a potentially existential threat underscores how important it is.
Commercial real estate
There was a time when wealthy business people would show up on CNBC, make a very opinionated case for something or other, and people would think they were sharing some important insight. Perhaps it’s just me being cranky, but I think those days are mostly over.
When I see news of Barry Sternlicht complaining about rates being too high and the damage it will do to the economy, I don’t see a knowledgeable business person offering thoughtful commentary about public policy. I see someone who got insanely rich from making risky bets in an environment of persistently low interest rates starting to get seriously squeezed - and seriously complaining about it. Why can’t he be a grown-up and just admit he made a huge directional bet that worked great for a while … and then didn’t. Crocodile tears.
This is a nice, simple insight by @RobinBrooksIIF. While copper has rebounded considerably off its bottom, oil has barely budged. Brooks reconciles the inconsistency: Copper is more a function of China reopening, while oil is more reflective of global economic weakness.
The fact this seems somewhat evident in hindsight reveals another insight: All too many of us substitute “China” for emerging markets or “rest of world”. It’s not. China is big and important, but it’s not everything. To that point, China’ reopening is important, but so too is the economic weakness being experienced in many other parts of the world.
The main point Brent Donnelly makes in this regular piece on trading instruction is the importance of being flexible. Absolutely this is true for trading, but it is also true for longer-term investors as well.
One of the red flags I always look out for in research providers and commentators is the degree to which they stick to a particular story line, i.e., are inflexible. This is no small task as a good story can go a long way in gaining eyeballs and ultimately compensation. Those are very different things than good investment performance though. I always discount the usefulness of providers who are too dogmatic and have difficulty evaluating alternate perspectives.
A related point is to take any perspective, story line, recommendation, etc. with a fair amount of skepticism. This doesn’t mean to assume they are wrong. It mainly recognizes how difficult it is to understand the totality of another person’s investment rationale based on just a short pitch. A third party recommendation should be treated as the beginning of a course of inquiry, not the end of the journey. A big reason why I publish Observations is so investors can get more acquainted with how I think about things and with the assumptions I make.
Donnelly’s warning would be hilarious if not so spot-on about the dangers of blindly following someone else’s ideas:
Trade your own view. If you trade someone else’s idea, you will inevitably do everything wrong. You will stop out at the wrong levels because your conviction will not be high when the trade goes against you. Also, if you are trading someone else’s view, you might not know when their view changes.
One message that might be taken from the strong performance of stocks to start the year and the “hair on fire” performance since the FOMC meeting is there is something going on that investors need to be a part of. Another, different, message is this is just a normal part in the stages of a bubble. “Return to normal” does have a nice, welcoming ring to it.
While the call to join the party may be tempting, long-term investors should keep two things in mind. First, an important part of the reason bubbles fizzle out is because there just aren’t any “fools” left to sell out to. Once that supply is exhausted, as @MarkGutman9 points out, it can be a long way down until a different set of investors gets interested in buying.
Second, investments are always subject to exogenous risks and despite volatility plunging to new recent lows, there is no shortage of major risks that can dramatically upset the playing field.
For instance, Japan could change course on monetary policy when its new central bank chief comes in. That could cause a lot of Japanese savings to leave foreign bonds (raising yields) and return home. There could easily be a reheating of geopolitical conflict which could put serious pressure on commodities again, this time with fewer shock absorbers. The asset backed securitization business could start winding down in a haphazard way. Any of these factors could cause a serious threat to financial stability and it is quite possible ALL of them could at the same time.
One takeaway for long-term investors then is to acknowledge that stocks are still extremely expensive and to realize the latest rally just makes that condition even worse. Another takeaway is for as long as excess cash resides in the financial system, there will be bouts of wild speculation. This will continue complicating decisions for investors and policymakers alike.
Finally, and to that point, the potential for wild speculation is wildly inconsistent with the Fed’s goal of ensuring financial stability. This hasn’t caused problems yet, but it is one more risk to put on the radar.
Thanks for reading Observations by David Robertson! Subscribe for free to receive new posts and support my work.
Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.
This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information.
Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.
This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.
This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.